Oil and Gas Depletion Worksheet

The Oil and Gas Depletion Worksheet is a tool used to calculate a tax deduction for owners and operators of oil and gas properties. This deduction accounts for the gradual depletion of these non-renewable resources over time. There are two primary methods for calculating depletion: cost depletion and percentage depletion.

What is Depletion?

Depletion, in the context of oil and gas, recognizes that these resources are finite and their extraction reduces the overall value of the property. The depletion deduction allows oil and gas companies to recoup a portion of their investment in the property, reflecting this decline in value.

Two Methods for Calculating Depletion:

There are two primary methods for calculating depletion:

A. Cost Depletion: This method deducts a proportional share of the original cost of the property (including acquisition and development costs) based on the volume of oil and gas extracted during the tax year.

B. Percentage Depletion: This method allows a deduction based on a fixed percentage (established by the IRS) of the gross income received from the property during the tax year.

Important Note: The taxpayer must use the method that results in the larger deduction. The worksheet typically focuses on calculating percentage depletion.

What is Percentage Depletion?

Percentage depletion is a simplified method that allows a taxpayer to deduct a fixed percentage of their gross income from the oil and gas property. This percentage is set by law and varies depending on the resource:

    • 15% for natural gas wells
    • 22% for oil and gas wells (excluding those extracting from secondary or tertiary production methods)
    • 10% for oil production from secondary or tertiary production methods (methods used to extract additional oil after primary extraction)

An example:

Imagine a mining company earns $100,000 in gross income from a specific mine in a year.

The statutory depletion rate for the mined resource is 15%.

The company can deduct $15,000 (100,000 x 15%) from its taxable income using percentage depletion.

Which depletion method should I use?

You should always calculate both cost depletion and percentage depletion and choose the method that results in the larger deduction for your specific situation.

What are the limitations of percentage depletion?

The 65% of taxable income limitation can restrict the deduction for high-income earners. Additionally, percentage depletion cannot be used for certain types of oil and gas wells, such as those extracting shale oil or gas from unconventional sources.

How do royalty payments affect the worksheet?

Royalty payments made to landowners are subtracted from gross income when calculating both percentage depletion and the gross income limitation.

What happens if my depletion deduction exceeds the limitations?

Any excess depletion is recorded as a statutory depletion carryover, which can be used to reduce your taxable income in future years.

Do I need to file the worksheet separately?

The worksheet itself is not typically filed with your tax return, but the calculated depletion deduction is transferred to the appropriate tax form (e.g., Schedule K-1 for partnerships).